The UK wants to be a land of unicorns

The UK's innovation ecosystem is lagging behind its US counterpart in the scaling of startups to unicorns – enterprises worth more than $1bn – and to make up that shortfall the government needs to shift its focus.

Author: Thierry Heles, editor

It has been quite an eventful couple of summer months. Touchstone Innovations, the commercialisation firm spun out from Imperial College London, now faces the very real prospect of a hostile takeover by its peer IP Group, after the latter secured the approval of 90% of the target’s shareholders.

The UK government was also busy, with the Treasury finally releasing its consultation on the long-awaited – and somewhat dreaded – patient capital review. The document invites a deeper analysis of what the country aims to become over the next years as it chases prosperity outside the EU.

The country’s innovation ecosystem is lagging behind its US counterpart in the scaling of startups to unicorns – enterprises worth more than $1bn – and to make up that shortfall the government needs to shift its focus. That is the fundamental idea driving the consultation.

Figures published in the document – Financing growth in innovative firms – are startling. Venture capital investments in private businesses in the UK stand at approximately £4bn ($5.2bn) a year, which may seem a lot at first but in fact equates to only about half the level of investments in the US. Follow-on rounds are also rarer for UK-based companies than those in the US. In fact the remainder of Europe outperforms the UK in third and fourth funding rounds, though the mainland drops below the UK’s performance for later stages (see chart below).

The consultation could be criticised for holding up the US as the gold standard – it hardly considers China, or indeed Asia, apart from acknowledging that 23% of unicorns in the world are based in the People’s Republic. The percentage is below that of the US, at 54%, but a report by China Money Network in May 2017 revealed that of 102 Chinese unicorns, worth a combined $435bn, six of the top 15 startups operate in the fintech sector – an area that the UK, and London with its global financial hub in particular, has been keen on.

The geopolitical and cultural differences with China may have played a part in the consultation largely ignoring that ecosystem, though when it comes to patient capital, that country and the region are essentially without peers – Tsinghua University alone committed $1.5bn to commercialisation fund Tsinghua Technology Transfer Fund as part of a $7.6bn initiative to support research activities over five years, for which the institution received the GUV fundraising of the year award 2017.

The same is true of government venturing, where so-called government guidance funds have been sprouting up across China and raising jaw-dropping sums, such as the $17.4bn fund created by Tianjin City, a $21.8bn vehicle launched by the Beijing government, and a fund reportedly being raised by the provincial government of Hubei with an $80bn target. Other governments have also been busy, with Singapore state-owned investment firm Temasek revealing a portfolio value of $197bn – a jump of nearly 13.4% over the previous year – in its annual report published in July.

And when it comes to corporate venturing, one need look no further than Japan-based telecoms and internet group SoftBank’s $93bn Vision Fund, which is targeting a $100bn close and has attracted investors such as China-based electronics contract manufacturer Foxconn and US-based technology company Apple, as well as multiple sovereign wealth funds including Saudi Arabia’s Public Investment Fund.

While editor-in-chief James Mawson has taken an in-depth look at what the consultation means for corporate and government venturing (see comment) one question remains – what does the consultation mean for university venturing?

With details of the government’s National Investment Fund, also announced in August, still vague – neither a structure nor a target size have been decided – only one thing is clear when it comes to that initiative – it aims to help startups become unicorns.

That realisation dashes any hopes that the National Investment Fund could be a proof-of-concept vehicle, a wish harboured more or less openly by many technology transfer offices (TTOs) up and down the country. In fact, the government appears to have little or no interest in the early stage.

The consultation recognises that spinouts are “typically pre-revenue, research and development-intensive and reliant on significant external equity investment” and that they “play an important role in the wider investment market”.

Numbers collected by high-growth company database provider Beauhurst, cited in the document, show that between 2011 and 2016, spinouts were responsible for 9% of investments and 12% of capital.

Intriguingly, the consultation counted 45 spinout deals in 2011 and an average of 85 a year from 2014 to 2016, with a total of £370m invested in 2011 to £340m a year in 2014, 2015 and 2016. The activity was mostly concentrated in London and the southeast, the east of England and the southwest – with other regions across the UK struggling to attract capital.

The figures do not line up with data collected by Global University Venturing, which shows that, between 2013 and 2016, spinouts from University of Oxford alone raised a total of almost $2.25bn, closely followed by University of Cambridge at just over $2bn, as the graph below illustrates.

Only in third place do we find a US institution, with Stanford University’s spinouts raising approximately $1.94bn. In fact, of the top 10 universities, half are in the UK – a more than respectable showing in the league table.

Ignoring that discrepancy for a moment, the consultation does not dispute that the UK is good at generating spinouts – and it even acknowledges that, outside London, spinouts “make a significant contribution to overall levels of investment in technology-focused firms”. It challenges the notion that the ecosystem is good at supporting young businesses through to initial public offering, and indeed beyond that, and to scale to more than 250 employees – the point at which, under EU guidelines, businesses cease to fall into the small and medium-sized enterpsise (SME) category.

There is a concern that the consultation may shift the focus too much to later-stage funding, particularly when it comes to spinouts.

Unicorns are great, but rare. So how do universities and their TTOs continue to gain value from knowledge transfer when it is made easier to raise a series E round – which a TTO may or may not able to afford to join – than it is to secure proof-of-concept backing or when founders, including TTOs, are forced to take a lower equity stake to begin with?

Brian McCaul, chief executive of Qubis, the tech transfer office of Queen’s University Belfast, previously wrote in Global University Venturing that there are good reasons why universities want a large stake to begin with, dismantling the myth that the US is more founder-friendly and taking particular issue with the fact that the equity stake usually serves as “a scapegoat for the perceived inefficiencies of university-to-business technology transfer”.

To its credit, the consultation notes that “changes in ownership reduce a founder’s ability to retain control of their business, reducing their own motivations for considering specific ownership structures that require founders to relinquish all control of their business. Equally, if a founder’s shareholding is diluted excessively, their motivation for driving the business forward may also be diluted excessively”.

Some – or indeed most – institutions would arguably be more disadvantaged if they were forced to take a lower equity stake to begin with and buy their way back in through later rounds. University venture funds such as Oxford Sciences Innovation, the UCL Technology Fund and university-affiliated vehicles such as Cambridge Innovation Capital may have the resources to do that, but regions that already struggle to attract venture capital today will suffer even more.

As McCaul wrote, attracting cash is “very much connected to the issue of place and context – in Northern Ireland this is harder than in San Diego or the southeast of England”.

Putting the US on a pedestal by considering only the macro picture ignores a key factor – not every institution in the US is equally successful in raising money for its spinouts.

The cliché that the UK’s institutions should try to be more like Stanford University also overlooks the fact that Stanford is in the unique position of being literally around the corner from Sand Hill Road, the heartland of venture capital in the US, and Silicon Valley. Really, the only place that could be considered remotely similar in the UK would be the golden triangle of London, Oxford and Cambridge, which, as we have seen above, is already doing well compared with the US. And the government’s own figures show that London is receiving more capital than other places.

That did not stop the UK government from seeking the advice of Katharine Ku, director of Stanford University’s office of technology licensing, last year on how a model of less equity could work for UK institutions. Ku at the time recommended that universities license inventions in return for a fee rather than equity – yet young companies often have little money to spare.

Since the government published its consultation paper, Imperial College London has announced the launch of its Founders Choice program, which will allow academic staff with a previous spinout under their belt to retain 95% in return for a minimal amount of support.

The pilot has a lot of potential, though as Tom Hockaday, founder of consultancy Technology Transfer Innovation and former head of tech transfer office Oxford University Innovation, points out in his guest comment: “The challenge for Imperial College and the others involved in Founders Choice will be how to resist supporting those who choose not to have the support, but find they need it.

“There is likely to be a gradual increase in those exercising the Founders Choice to own more shares, without the expected decrease in resources the TTO consumes in helping.

“Assuming the academics rule, as they usually do in top universities, in a couple of years Imperial College will be holding a large number of small shareholdings, and as Imperial is smart, it will have found a way to invest in follow-on rounds in the ones looking good. This may fit nicely with the ending of the Imperial College pipeline deal with Touchstone in 2020.”

And what about those other US institutions? At this year’s GUV:Fusion conference, Lesleyl Millar-Nicholson, director of the technology licensing office of Massachusetts Institute of Technology (MIT), pointed to the privileged reality in which MIT finds itself, remarking just how much easier it was to secure funding for spinouts than it had been in her previous job with University of Illinois at Urbana-Champaign.

How the UK government foresees solving the problem of making sure a spinout from a university in Northern Ireland or the north of England can make it through to a later-stage round remains a mystery.

Yes, a government venturing fund such as the National Investment Fund could certainly help here, as could regional university venture funds – which the consultation does not pick up on, despite the enormous potential such schemes have.

How are universities meant to avoid being forced soon to accept a 5% share rather than a 50% stake in spinouts? Now that the time to react to the government’s consultation has passed – the deadline was September 22 – they should keep their fingers crossed that the powers-that-be listen to any concerns that were put to them, including by the Global University Venturing Leadership Society, a body that brings together tech transfer leaders from across the world.

In its recommendations, the society noted that “spinouts are also just the tip of the iceberg in terms of university engagement with entrepreneurialism. Licensing and proof-of-concepts are hugely important areas for helping turn the best minds’ ideas into useful innovations and inventions that can be commercialised”.

It continued: “More broadly, a focus on spinouts can miss the role students, post-graduates and faculty can play in working for entrepreneurial businesses and passing on their research and ideas and seeing the theory work in practice to shape their later academic studies. Encouraging these links beyond just a focus on counting spinouts and scaling them up through patient capital can be helpful for national productivity but also helpful for one of the UK’s largest export industries – the universities themselves.

“Universities have as much to gain from understanding the ideas and work that their students and faculty develop as they have in seeing these ideas becoming commercially successful or developed into a scaled-up enterprise. In this context, giving the universities encouragement that this is regarded in their funding as strategically important remains helpful. But they also need flexibility to find and iterate on their approach with spinouts and startups.”

What if the government ignores these calls and goes ahead anyway? Perhaps now is the time for smaller institutions to consider regional university venture funds – calls that have been getting louder in the ecosystem anyway – or to set up joint commercialisation efforts, such as that of Newcastle and Durham universities, Northern Accelerator.

The danger then, of course, becomes whether there are enough experienced investors to avoid a long-term issue, such as shareholders backing mergers as typified by the continuing IP Group and Touchstone Innovations saga mentioned above.

The UK may be sailing towards unchartered waters and it can certainly consider itself lucky that it has some of the finest tech transfer leaders among its people. But that the consultation does not appreciate the enormous dedication these people put in every day is perhaps another sign that it does not really understand the sector and is blinded by its unicorn dream.

There is another factor the consultation brushes over – infrastructure. In its 76 pages, it refers to incubators and accelerators only once each – the first in a graph about the ecosystem, the second to say that there are 163 accelerator programs in the UK. That is a heartening number, but it hardly offers an in-depth picture of the impact of those programs.

What is more, the document does not name any of them – surprisingly, not even SetSquared, the collaboration involving the universities of Bath, Bristol, Exeter, Southampton and Surrey that has not only been named the best incubator in the world but that surely could serve as an inspiration and a model for other small to medium-sized institutions looking to boost their local ecosystem.

True, incubators traditionally serve early-stage businesses, but as programs such as Y Combinator in the US prove, they are often instrumental in setting companies up for unicorn status later.

All the while there is a danger that a focus on patient capital will be undone by the UK’s impending departure from the EU, which may well lead to a morass of regulatory hurdles that prevent startups from expanding into the EU – a unicorn that cannot expand into neighbouring countries will not appear to be a target worth chasing.

The lack of funding from the EU-owned European Investment Fund, which has largely halted investments in the UK, has also been recognised by other actors responding to the consultation. Phil Hall, head of public affairs and public policy at professional body the Association of Accounting Technicians – whose members provide accountancy services to more than 400,000 UK businesses – noted the need for the country to remain a member of the EIF. If that proves impossible, Hall calls for the UK government’s economic development agency British Business Bank to step in. But the £2bn funding gap left by the EIF is a substantial figure – even if the consultation claims expanding the British Business Bank’s activities could be done “simply”.

It is, in principle, a good thing that a consultation is taking place because the ecosystem does undoubtedly need more mature startups and more patient capital. There is also no doubt that TTOs will adapt to whatever Westminster may throw at them. Let us just hope it will not be too much of a curveball.

But in a surreal example of the many-headed beast that is Westminster, a report – Managing intellectual property and technology transfer – published by the House of Commons Science and Technology Committee earlier this year, noted that “the government’s patient capital review must engage with the university sector and learn from those universities that have developed patient capital schemes”.

While it is true that universities, much like other parties, were able to send in their views, it is arguably a stretch to call this active engagement. Does this bode well that the government will truly listen to input from the sector? The odds are not as good as they should be.

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